DC Circuit Finds Buyers in Transactions Under Exon-Florio Review Are Entitled to Due Process Protections

Friday, August 1, 2014

In a sweeping decision in Ralls Corporation v. Committee on Foreign Investment in the United States,1 a three-judge panel of the U.S. Court of Appeals for the District of Columbia Circuit (DC Circuit) unanimously concluded that, among other things, the due process rights of Ralls Corporation (Ralls), as buyer, were violated as a result of the failure of the Committee on Foreign Investment in the United States (CFIUS) and the President (1) to share with Ralls the unclassified materials on which they relied in concluding that the buyer might pose a threat to U.S. national security and (2) to provide Ralls with an opportunity to rebut the allegations in those unclassified materials. This decision reverses a ruling by the U.S. District Court for the District of Columbia (DC District Court) holding, among other things, that a buyer in a transaction subject to review under section 721 of the Defense Production Act of 1950, as amended (Exon-Florio), had no due process rights relating to the acquired property. The appellate decision thus appears to require certain changes to the way that CFIUS conducts the review of transactions under Exon-Florio.

This client alert summarizes the key components of the DC Circuit’s Ralls decision. The full text of the court’s decision is available here.

Background

Exon-Florio process. Under Exon-Florio and its implementing regulations, the President and CFIUS, a committee composed of the U.S. Attorney General, the heads of the Office of U.S. Trade Representative and Office of Science & Technology Policy, and the Secretaries of the Departments of Treasury, Homeland Security, Commerce, Defense, State and Energy (or their respective designees), have the power to review the national security effects of transactions that give foreign persons control over a U.S. business.2 Such review may be initiated (either before or after a transaction is consummated) by the parties to the transaction or by CFIUS sua sponte. Upon a recommendation from CFIUS, the President is authorized, among other things, to block a transaction that has not yet closed and to reverse a transaction that has already closed, in each case if the President concludes that such transaction may adversely affect U.S. national security and other laws are not adequate to protect the United States from such danger.3

Ralls transaction. In March 2012, Ralls, the plaintiff-appellant, purchased four limited liability companies (Project Companies) with wind farm projects in north-central Oregon. Ralls, a Delaware corporation, is owned by two Chinese nationals who are also senior executives of Sany Group, a Chinese manufacturing company (Sany). Three of the wind farm sites owned by the Project Companies are near restricted airspace used by U.S. military aircraft. The fourth is within that restricted airspace. Ralls did not submit the transactions to CFIUS for pre-acquisition review, but did make a “voluntary” post-acquisition notification to CFIUS after being asked to do so by the government. CFIUS issued an interim order (CFIUS Order) broadly requiring Ralls to cease all activities at the four wind farm sites, to remove items from those sites, to restrict access to those sites to U.S. citizens approved by CFIUS, to refrain from selling any items manufactured by Sany to third parties, and to refrain from selling the wind farm projects to any third parties without prior notice to (and consent from) CFIUS. Subsequently, CFIUS transmitted a report to the President that recommended divestiture. The govern­ment did not provide a copy of the report (or excerpts thereof) to Ralls.

On September 28, 2012, the President issued his own order making certain findings and requiring certain actions (Presidential Order). The President found that there was credible evidence that led him to believe that Ralls, Sany and others, through the control of the wind farms “might take action that threatens to impair the national security of the United States” and that provisions of existing law did not mitigate these threats. The Presidential Order revoked the CFIUS Order’s restrictions and imposed its own, similar restrictions. The Presidential Order did not specifically identify what the actions or threats were.4

DC District Court decisions. Ralls filed a complaint against CFIUS in the DC District Court prior to the issuance of the Presidential Order and subsequently amended the complaint to add the President as a defendant. In a case of first impression, the court dismissed Ralls’ claims that the CFIUS Order exceeded CFIUS’s statutory authority and was arbitrary and capricious as moot. The court also concluded that Ralls’ claims that the President’s actions were ultra vires and denied it equal protection under the law failed for various reasons. The court reserved decision on the substance of Ralls’ due process claim for a hearing after further briefing by the parties.5

In October 2013, the DC District Court addressed the two questions left open by its earlier decision. The court concluded that Ralls had not in fact acquired any constitutionally-protected interests when it acquired the Project Companies. This aspect of the court’s ruling was based on a number of legal theories, including that Ralls had undertaken “the transaction and volun­tarily acquired those state property rights subject to the known risk of a Presidential veto.”6 The court also found that, even if Ralls had acquired a constitutionally-protected interest entitled to due process, it had received sufficient due process. The court found that the undisputed facts revealed that Ralls was given notice before a decision was made and that its views were submitted to CFIUS. These findings left merely the argument that Ralls was entitled to know the President’s unclassified reasons for prohibiting the transaction and to have an opportunity to rebut those reasons. The court concluded that, in light of the process that Ralls was already afforded and the limited nature of the additional process that it sought, the factors “in this case weigh overwhelmingly in favor of the government.” The court, therefore, dismissed the remaining count of Ralls’ complaint.

DC Circuit Decision

On appeal, the DC Circuit first addressed Ralls’ due process claim as it relates to the Presidential Order and then turned to all of the remaining claims as they relate to the CFIUS Order.

The Presidential Order claim. In the lower court proceeding, the DC District Court had concluded that the government had failed to meet the high burden of proving, by clear and convincing evidence, that Congress intended to preclude judicial review of Ralls’ due process claim. On appeal, the gov­ern­ment again argued that Exon-Florio precluded judicial review of the due process claim. The DC Circuit disagreed. Citing three prior DC Circuit decisions, the appellate panel concluded that the actual text of 50 U.S.C. app. § 2170(e) did not provide “clear and convincing” evidence of Congress’ intention to bar judicial review of constitutional claims. Among other things, the court noted that the statutory bar did not apply to all claims relating to Exon-Florio, but only to “actions of the President under paragraph (1) of subsection (d).”7 The court also noted that there was no legislative history expressly addressing judicial review of constitutional claims arising from the implementation of Exon-Florio.

Next, the DC Circuit turned to the government’s argument that Ralls’ claims presented a non-justiciable political question. On this issue, the court focused its analysis on People’s Mojahedin Organization of Iran v. Department of State, 182 F.3d 17 (DC Cir. 1999). In that case, the Peoples’ Mojahedin Organization of Iran (PMOI) challenged the U.S. Department of State’s designation of it as a “foreign terrorist organization” under the Antiterrorism and Effective Death Penalty Act of 1996 (AEDPA). Under the AEDPA, the Secretary of State could designate an entity as a “foreign terrorist organization” if (1) the organization is foreign, (2) it engages in terrorist activity, and (3) the terrorist activity threatens U.S. national security or U.S. nationals. Notwithstanding the foreign policy implications of the “foreign terrorist organization” designation, the DC Circuit had found in these earlier cases that the first two elements of that designation were judicially reviewable. In the court’s view, only the third element in PMOI was a political question and non-justiciable. Likening Ralls’ request that the court decide whether the due process clause entitles it to have notice of, and access to, the evidence on which the President relied to the justiciable elements in the PMOI case, the court concluded that Ralls’ request for access to unclassified information was justiciable.

The court then evaluated Ralls’ procedural due process claims. The DC Circuit emphatically disagreed with the lower court on this issue. It observed that Ralls’ property rights in the wind farms were fully vested under state law. And it endorsed Ralls’ argument that “the Federal Government cannot evade the due process protections afforded to state property by simply ‘announcing that future deprivations of property may be forthcoming.’”8

Finding that Ralls’ interests in the wind farms were protected by due process, the DC Circuit turned to the question of what process was due. The court once again looked to the cases involving the AEDPA for guidance. Reviewing a “foreign terrorist organization” designation under the AEDPA against a due process challenge, the DC Circuit had previously held that an affected party could not be deprived of its interest in a small bank account “without first receiving notice of the proposed designation, access to the unclassified evidence supporting the designation and an opportunity to rebut that evidence.”9 The court therefore concluded that Ralls and its $6 million investment in the Project Companies were entitled to similar protections. In light of Ralls’ not having received such unclassified information and an opportunity to rebut, the court concluded it had been deprived of property without due process.

The CFIUS Order claims. The DC District Court had dismissed Ralls’ claims relating to the CFIUS Order as moot since the Presidential Order revoked the CFIUS Order. On appeal, the DC Circuit agreed with the DC District Court that the claims were ostensibly moot, but reached a different conclusion on the question of whether the claims relating to the CFIUS Order ought to be reviewed anyway under the “capable of repetition yet evading review” exception to the mootness doctrine. The DC Circuit found that the case met the “evading review” exception to mootness and directed the DC District Court to address the merits of these claims on remand.

Practical Implications

The DC Circuit’s decision in Ralls represents vindication for the plaintiff-appellant and a substantial rejection of the government’s legal theory. Also, while some may be inclined to read the decision as narrowly applying only to the relatively rare case (likeRalls) in which the notice is filed after the foreign buyer completed its acquisition and actually has acquired property rights under state law, the DC Circuit suggested that it would not agree. In a footnote addressing the government’s argument that Ralls “waived” constitutional protections by not utilizing the processes afforded to it, the court stated: “We read [the cases addressing waiver] to say that a party ‘waives’ a due process claim only if he foregoes constitutionally adequate procedures…. There is no indication that the process Ralls received after the transaction was completed is different from the process it would have received had it sought pre-approval – and, as discussed infra, that process was inadequate.”10

In the short run (at least until the government seeks and obtains either a stay or reversal of the decision or legislative changes), the Ralls decision is likely to force changes in the way that certain CFIUS submissions are handled. CFIUS will now be required to build into its process adequate time to determine what information it has that is unclassified, to distribute that information to the notifying party and to allow the notifying party an opportunity to rebut that information. It is also possible, at least in some highly contentious cases, that the President will claim “executive privilege” and that privilege and other issues will need to be sorted out in the DC District Court.

At the same time, the practical effects of the DC Circuit’s Ralls decision on the outcomes of Exon-Florio reviews are likely to be limited. A substantial, if not overwhelming, portion of the information relied upon by CFIUS and the President in reaching their respective decisions is likely to be classified. Neither the DC District Court nor the DC Circuit went so far as to require that disgruntled parties to such proceedings should have access to classified information nor was either court prepared to review the President’s conclusion that a foreign person might take action that threatens to impair the national security of the United States.

8.Id. at *13 (citing Br. for Appellant 21, Ralls Corp. v. Comm. on Foreign Inv. in the U.S., No. 13-5315 (DC Cir. Feb. 7, 2014)). The DC Circuit distinguished a situation where a federal statute made a transfer void ab initio from one where the statute subjected a transfer to review that might result in the transfer being undone. In the former situation, the DC Circuit had previously found that no due process rights attached because the ostensible owner never actually acquired a property interest in the underlying property.

9.Id. at *15 (citing National Council of Resistance of Iran v. Dept. of State, 251 F.3d at 201, 208-09 (DC Cir. 2001)).

Eric R. Markus is a partner in the firm's Corporate/Securities practice. Eric has a broad practice that encompasses complex corporate transactions, mergers and acquisitions, securities law compliance and debtor and creditor representations in bankruptcy proceedings.

The matters on which he has counseled clients include:

Private and public M&A transactions, including domestic and international targets

Matthew Nielsen is a partner in the firm’s Corporate Compliance, Investigations and Defense practice group. Matthew's practice focuses on conducting internal investigations; assisting clients in civil and criminal matters before the U.S. Department of Justice, the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority (FINRA), state securities boards and state attorneys general; and representing clients in securities litigation. In his investigation practice, Matthew has represented boards of directors, audit committees, and small to Fortune 100-companies in matters that include alleged violations of federal and state securities laws, embezzlement and self-dealing, complaints from whistleblowers, earnings manipulation and other accounting fraud, Medicaid fraud, and Foreign Corrupt Practices Act violations. In his regulatory work, Matthew represents public companies, directors and officers, accountants, broker-dealers, investment advisers, and registered individuals in SEC and FINRA compliance examinations and enforcement investigations and proceedings.

Matthew also has substantial litigation and trial experience, in state and federal court, as well as arbitration, successfully handling disputes that include securities fraud, shareholder and closely-held company litigation, legal and accounting malpractice, employment discrimination, complex contractual matters and injunctions.

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